European Economy
Convergence Report 2007 on Malta – Technical Annex
A Commission services working paper
SEC(2007) 622
Aknowledgements
The Convergence Report and its Technical Annex were prepared in the Directorate-General for Economic and Financial Affairs. The main contributors were Pavlína Žáková and Paul Kutos.
Other contributors to the paper were Sean Berrigan, Ivan Ebejer, Christine Gerstberger, Fabienne Ilzkovitz, Baudouin Lamine, Claudia Lindemann, Lucio R. Pench, Nuno Sousa, Andreas Trokkos, Charlotte Van Hooydonk and Johan Verhaeven.
Statistical assistance was provided by André Verbanck and Gerda Symens.
The paper was coordinated by Massimo Suardi, and approved by Servaas Deroose, Director, and Klaus Regling, Director-General.
Contents
1. INTRODUCTION...... 1 1.1. Role of the report...... 1 1.2. Application of the criteria ...... 2 2. LEGAL COMPATIBILITY...... 10 2.1. Legal situation...... 10 2.2. Assessment of compatibility ...... 11 3. PRICE STABILITY...... 12 3.1. Respect of the reference value...... 12 3.2. Recent inflation developments...... 12 3.3. Underlying factors and sustainability of inflation...... 13 4. GOVERNMENT BUDGETARY POSITION ...... 17 4.1. The excessive deficit procedure for Malta ...... 17 4.2. Developments until 2006 ...... 17 4.3. Medium-term prospects...... 18 5. EXCHANGE RATE STABILITY...... 20 6. LONG-TERM INTEREST RATES ...... 22 7. ADDITIONAL FACTORS...... 23 7.1. Financial market integration...... 23 7.2. Product market integration...... 24 7.3. Development of the balance of payments ...... 27
List of Tables
Table 1. Inflation reference value in previous and current Convergence Reports Table 2. Malta: Components of inflation Table 3. Malta: Other inflation and cost indicators Table 4. Malta: Budgetary developments and projections Table 5. Malta: Product market integration Table 6. Malta: Balance of payments
List of Charts
Chart 1. Malta: Inflation criterion since May 2004 Chart 2. Malta: HICP inflation Chart 3. Malta: Inflation, productivity and wage trends Chart 4. Nominal effective exchange rate: MTL Chart 5. MTL: Spread vs central rate Chart 6. Exchange rates: MTL/EUR Chart 7. Malta: 3-M Mibor spread to 3-M Euribor Chart 8. Malta: Long-term interest rate criterion Chart 9. Malta: Long-term interest rates Chart 10a. Malta: Structure of financial system relative to EU-10 and Euro area Chart 10b. Malta: Foreign ownership and concentration in the banking sector in 2005 Chart 10c. Malta: Domestic credit expansion Chart 10d. Malta: Share of foreign currency loans
List of Boxes
Box 1. Article 122(2) of the Treaty Box 2. Article 121(1) of the Treaty Box 3. Assessment of price stability and the reference value Box 4. The excessive deficit procedure
Abbreviations and symbols used
Member States BE Belgium BG Bulgaria CZ Czech Republic DK Denmark DE Germany EE Estonia EL Greece ES Spain FR France IE Ireland IT Italy CY Cyprus LV Latvia LT Lithuania LU Luxembourg HU Hungary MT Malta NL The Netherlands AT Austria PL Poland
PT Portugal RO Romania SI Slovenia SK Slovakia FI Finland SE Sweden UK United Kingdom
EU10 European Union Member States that joined the EU on 1 May 2004 (CZ, EE, CY, LT, LV, HU, MT, PL, SI, SK) EUR13 European Union Member States having adopted the single currency (BE, DE, EL, ES, FR, IE, IT, LU, NL, AT, PT, SI, FI) EU15 European Union, 15 Member States before 1 May 2004 (EUR-12 plus DK, SE and UK) EU25 European Union, 25 Member States before 1 January 2007 EU27 European Union, 27 Member States
Currencies EUR euro ECU European currency unit USD US dollar MTL Maltese lira
Other abbreviations CBM Central Bank of Malta CPI Consumer price index CR5 Concentration ratio (defined as the aggregated market share of five banks with the largest market share) ECB European Central Bank EDP Excessive Deficit Procedure EMI European Monetary Institute EMU economic and monetary union ERM II exchange rate mechanism II ESCB European System of Central Banks Eurostat Statistical Office of the European Communities FDI foreign direct investment GDP gross domestic product GFCF gross fixed capital formation HICP harmonised index of consumer prices ICT information and communications technology MTO medium-term objective MFSA Malta Financial Services Authority PPS Purchasing Power Standard SGP Stability and Growth Pact ULC unit labour costs VAT value added tax
1. INTRODUCTION
1.1. Role of the report Box 1: Article 122(2) of the Treaty
"At least once every two years, or at the request of a The euro was introduced on 1 January 1999 by eleven Member State with a derogation, the Commission and Member States, following several years of successful the ECB shall report to the Council in accordance adjustment efforts to achieve a high degree of with the procedure laid down in Article 121(1). After sustainable convergence. The decision1 by the consulting the European Parliament and after Council (meeting in the composition of the Heads of discussion in the Council, meeting in the composition State or Government) on 3 May 1998 in Brussels on of the Heads of State or Government, the Council the eleven Member States deemed ready to participate shall, acting by a qualified majority on a proposal in the single currency (from the beginning) had, in from the Commission, decide which Member States accordance with the Treaty (Article 121(4)), been with a derogation fulfil the necessary conditions on prepared by the Ecofin Council on a recommendation the basis of the criteria set out in Article 121(1), and from the Commission. The decision was based on the abrogate the derogations of the Member States two Convergence Reports made by the Commission2 concerned." and the European Monetary Institute (EMI), respectively.3 These reports, prepared in accordance with Article 121(1) of the Treaty, examined in Denmark and the United Kingdom negotiated opt-out considerable detail whether the Member States arrangements before the adoption of the Maastricht 4 satisfied the convergence criteria and met the legal Treaty and do not participate in the third stage of requirements. EMU. Until these Member States indicate that they wish to participate in the third stage and join the Those Member States which are assessed as not single currency, they are not the subject of an fulfilling the necessary conditions for the adoption of assessment by the Council as to whether they fulfil the single currency are referred to as "Member States the necessary conditions. with a derogation". Article 122(2) of the Treaty lays down provisions and procedures for examining the Greece submitted a request on 9 March 2000 for its situation of Member States with a derogation (Box 1). convergence situation to be re-examined. The Ecofin 5 At least once every two years, or at the request of a Council adopted the decision that Greece fulfilled the Member State with a derogation, the Commission and necessary conditions for adoption of the single the European Central Bank (ECB) are required to currency on 19 June 2000. The decision was taken on prepare Convergence Reports on such Member States. the basis of a proposal from the Commission and having regard to the discussion of the Council, meeting in the composition of the Heads of State or Government. The decision was based on two
Convergence Reports made by the Commission6 and the ECB7, which covered both Greece and Sweden. Greece adopted the single currency with effect from
4 Protocol (No 26) on certain provisions relating to Denmark, Protocol (No 25) on certain provisions 1 OJ L 139, 11.5.1998, pp. 30-35. relating to the United Kingdom of Great Britain and 2 Report on progress towards convergence and Northern Ireland. recommendation with a view to the transition to the 5 OJ L 167, 7.7.2000, pp. 19-21. third stage of economic and monetary union, 6 European Commission, Convergence Report 2000, COM(1998)1999 final, 25 March 1998. COM(2000) 277 final, 3 May 2000. 3 European Monetary Institute, Convergence Report, 7 European Central Bank, Convergence Report 2000, March 1998. May 2000.
1 Convergence Report 2007 on Malta Technical annex
1 January 2001. Sweden was assessed in 2000 as not meet the necessary conditions for adopting the single fulfilling the necessary conditions for the adoption of currency. the single currency. On 27 February 2007, Malta submitted a request for a In 2002, the convergence assessment covered only convergence assessment. As a response to this Sweden and concluded that Sweden was not fulfilling request, the Commission and the ECB prepared the necessary conditions for the adoption of the single Convergence Reports for Malta. currency and continued to be referred to as a "Member State with a derogation".8 This Commission services working paper is a technical annex to the Convergence Report on Malta In 2004, Sweden was examined together with the ten and includes a detailed assessment of the progress countries that joined the EU on 1 May 2004. In with convergence. The remainder of the first chapter accordance with Article 4 of the Act of Accession, the presents the methodology used for application of the ten countries became upon entry “Member States with assessment criteria. Chapters 2 to 7 examine a derogation”. Although the maximum period referred fulfilment of each of the convergence criteria and to in Article 122(2) of the Treaty had not elapsed for other requirements in the order as they appear in these countries in 2004, the re-assessment of Sweden Article 121(1). The cut-off date for the statistical data was seized as an opportunity to analyse also the state included in the convergence report and in this of convergence in the new Member States. None of technical annex is 26 April 2007. the eleven assessed countries was considered to have fulfilled the necessary conditions for the adoption of the single currency.9 1.2. Application of the criteria
In 2006, two convergence assessments have been In accordance with Article 121(1), the convergence carried out. In May, the Commission and the ECB reports shall examine the compatibility of national presented reports on Lithuania and Slovenia, prepared legislation with the Treaty and the Statute of the at the request of the national authorities.10 While European System of Central Banks (ESCB) and of the Slovenia was deemed to fulfil all the convergence European Central Bank. The reports shall also criteria and to be ready to adopt the euro in January examine the achievement of a high degree of 2007, the report on Lithuania suggested that there sustainable convergence by reference to the fulfilment should be no change in the status of Lithuania as a of the four convergence criteria dealing with price Member State with the derogation. The remaining stability, the government budgetary position, nine Member States with a derogation were assessed exchange rate stability and long-term interest rates as in regular Convergence Reports issued in December well as some additional factors (Box 2). The four 2006.11 None of the countries assessed was deemed to convergence criteria have been developed further in a Protocol annexed to the Treaty (Protocol No 21 on the convergence criteria).
8 European Commission, Convergence Report 2002, COM(2002) 243 final, 22 May 2002; and European Central Bank, Convergence report 2002, May 2002. 9 European Commission, Convergence Report 2004, COM(2004) 690 final, 20 October 2004; and European Central Bank, Convergence Report 2004, October 2004. 10 European Commission, Convergence Report 2006 on Lithuania, COM(2006) 223 final, 16 May 2006; European Commission, Convergence Report 2006 on Slovenia, COM(2006) 224 final, 16 May 2006; and European Central Bank, Convergence Report May 2006, May 2006. On the basis of the reports, the Ecofin Council adopted on 11 July 2006 the Decision that Slovenia fulfilled the necessary conditions for adoption of the single currency (OJ L 195, 15.7.2006, pp 25-27). 11 European Commission, Convergence Report December 2006, COM(2006) 762 final, 6 December 2006; and European Central Bank, Convergence Report December 2006, December 2006.
2 Chapter 1 Introduction
Box 2: Article 121(1) of the Treaty
"1. The Commission and the EMI shall report to the Council on the progress made in the fulfilment by the Member States of their obligations regarding the achievement of economic and monetary union. These reports shall include an examination of the compatibility between each Member State's national legislation, including the statutes of its national central bank, and Articles 108 and 109 of this Treaty and the Statute of the ESCB. The reports shall also examine the achievement of a high degree of sustainable convergence by reference to the fulfilment by each Member State of the following criteria:
– the achievement of a high degree of price stability; this will be apparent from a rate of inflation which is close to that of, at most, the three best performing Member States in terms of price stability;
– the sustainability of the government financial position; this will be apparent from having achieved a government budgetary position without a deficit that is excessive as determined in accordance with Article 104(6);
– the observance of the normal fluctuation margins provided for by the exchange rate mechanism of the European Monetary System, for at least two years, without devaluing against the currency of any other Member State;
– the durability of convergence achieved by the Member State and of its participation in the exchange rate mechanism of the European Monetary System being reflected in the long term interest rate levels.
The four criteria mentioned in this paragraph and the relevant periods over which they are to be respected are developed further in a Protocol annexed to this Treaty. The reports of the Commission and the EMI shall also take account of the development of the ECU, the results of the integration of markets, the situation and development of the balances of payments on current account and an examination of the development of unit labour costs and other price indices."
Compatibility of legislation bank into the ESCB has to be examined, in order to ensure that the national central bank acts in In accordance with Article 121(1) of the Treaty, the accordance with the ECB’s guidelines and legal examination includes an assessment of instructions once the country concerned has adopted compatibility between a Member State’s legislation, the single currency. including the statute of its national central bank, and Articles 108 and 109 of the Treaty and the Statute of the ESCB/ECB. This assessment mainly covers three Price stability areas. First, the objectives of the national central bank The price stability criterion is defined in the first must be examined, in order to verify their indent of Article 121(1) of the Treaty: “the compatibility with the objectives of the ESCB as achievement of a high degree of price stability […] formulated in Article 105(1) and Article 2 of the will be apparent from a rate of inflation which is Statute of the ESCB/ECB. The ESCB’s primary close to that of, at most, the three best performing objective is to maintain price stability. Without Member States in terms of price stability”. prejudice to this objective, it shall support the general economic policies in the Community. Second, the Article 1 of the Protocol on the convergence criteria independence of the national central bank and of the further stipulates that “the criterion on price stability members of its decision-making bodies (Article 108) […] shall mean that a Member State has a price must be assessed. This assessment covers all issues performance that is sustainable and an average rate linked to a national central bank's institutional and of inflation, observed over a period of one year before financial independence and to the personal the examination, that does not exceed by more than independence of the members of its decision-making 1.5 percentage points that of, at most, the three best- bodies. Third, the integration of the national central performing Member States in terms of price stability.
3 Convergence Report 2007 on Malta Technical annex
Inflation shall be measured by means of the consumer Over the 12 month period covering April 2006-March price index on a comparable basis, taking into 2007, the three best-performing Member States in account differences in national definitions”. terms of price stability were Finland, (1.3%), Poland (1.5%) and Sweden (1.6%) yielding a reference value Since national consumer price indices (CPIs) diverge of 3.0%. substantially in terms of concepts, methods and practices, they do not constitute the appropriate means The Protocol on the convergence criteria not only to meet the Treaty requirement that inflation must be requires Member States to have achieved a high measured on a comparable basis. To this end, the degree of price stability but also calls for a price Council adopted on 23 October 1995 a framework performance that is sustainable. The requirement of regulation12 setting the legal basis for the sustainability aims at ensuring that the degree of price establishment of a harmonised methodology for stability and inflation convergence achieved in compiling consumer price indices in the Member previous years will be maintained after adoption of States. This process resulted in the production of the the euro. This implies that the satisfactory inflation Harmonised Indices of Consumer Prices (HICPs), performance must essentially be due to the adequate which have been used for assessing the fulfilment of behaviour of input costs and other factors influencing the price stability criterion. Until December 2005, price developments in a structural manner, rather than HICP series had been based on 1996 as the reference reflecting the influence of temporary factors. period. A Commission Regulation (EC) No Therefore, this technical annex examines also 1708/200513 provided the basis for a change of the developments in unit labour costs as a result of trends HICP index base reference period from 1996=100 to in labour productivity and nominal compensation per 2005=100. head, and developments in import prices to assess whether and how external price developments have As has been the case in past convergence reports, a impacted on domestic inflation. From a forward- Member State’s average rate of inflation is measured looking perspective, the report includes an assessment by the percentage change in the arithmetic average of of medium-term prospects for inflation. The analysis the last 12 monthly indices relative to the arithmetic of factors that have an impact on the inflation outlook, average of the 12 monthly indices of the previous such as credit developments and cyclical conditions, period. The reference value is calculated as the is complemented by a reference to the most recent arithmetic average of the average rate of inflation of Commission forecast of inflation. That forecast can the three best-performing Member States in terms of subsequently be used to assess whether the country is price stability plus 1.5 percentage points (Box 3). likely to meet the reference value also in the months ahead. 14
12 Council Regulation (EC) No 2494/95 of 23 October 1995 concerning harmonised indices of consumer prices 14 According to the Commission Spring 2007 Forecast, the (OJ L 257, 27.10.1995, pp. 1-4). reference value is forecast to stand at 2.8% in December 13 Commission Regulation (EC) No 1708/2005 of 19 2007. The forecast of the reference value is subject to October 2005 laying down detailed rules for the significant uncertainties given that it is calculated on the implementation of Council Regulation (EC) No 2494/95 basis of the inflation forecasts for the three Member as regards the common index reference period for the States projected to have the lowest inflation in the harmonised index of consumer prices, and amending forecast period, thereby increasing the possible margin Regulation (EC) No 2214/96. of error.
4 Chapter 1 Introduction
Box 3: Assessment of price stability and the reference value The numerical part of the price stability criterion implies a comparison between a Member State's average price performance and a reference value.
A Member State’s average rate of inflation is measured by the percentage change in the unweighted average of the last 12 monthly indices relative to the unweighted average of the 12 monthly indices of the previous period, rounded to one decimal.
This measure captures inflation trends over a period of one year as requested by the provisions of the Treaty. Using the commonly used inflation rate – calculated as the percentage change in the consumer price index of the latest month over the index for the equivalent month of the previous year – would not meet the one year requirement. The latter measure may also vary importantly from month to month because of exceptional factors.
The reference value is calculated as the unweighted average of the average rates of inflation of, at most, the three best-performing Member States in terms of price stability plus 1.5 percentage points. The outcome is rounded to one decimal. While in principle the reference value could also be calculated on the basis of the price performance of only one or two best performing Member States in terms of price stability, it has been existing practice to select the three best performers.
The reference value has been defined in the Maastricht Treaty in a relative way. An absolute reference value could, depending on the overall economic circumstances at the time of the assessment, be considered to be unduly harsh or too loose. Alternatively, using the average of the inflation rates of all Member States as a basis for the reference value would imply that high inflation rates of a few countries could increase the average to undesired levels. These problems are avoided in the Treaty by requiring convergence towards the best performing Member States within a margin of 1.5 percentage points. As the reference value is a relative concept based on the Member States with the lowest rate of inflation, a margin of 1.5 percentage points is added.
Article 121(1) of the Treaty refers to 'Member States' and does not make a distinction between euro area and other Member States. The Convergence Reports therefore select the three best performers from all Member States – EU15 for the Convergence Reports before 2004 and EU25 for the reports as of 2004.
As a principle, and in line with what was intended by the authors of the Maastricht Treaty, the Commission and ECB reports select as best performers in terms of price stability those Member States which have the lowest average rate of inflation. In the 2004 report, the Commission decided to exclude countries in deflation from the calculation of the reference value because these countries could not be considered to be 'best performers' in terms of price stability – as suggested by the Treaty Protocol, which refers only to an average rate of inflation.
Table 1 lists the reference value as used in the Convergence Reports issued since 1998.
5 Convergence Report 2007 on Malta Technical annex
Table 1. Inflation reference value in previous and current Convergence Reports 1) Convergence Report Cut-off month Three best Reference Euro area average 2) 2) adoption date performers value inflation rate
1998 January 1998 Austria, France, Ireland 2.7 1.5 2000 March 2000 Sweden, France, Austria 2.4 1.4 2002 April 2002 United Kingdom, Germany, France 3.3 2.4 2004 August 2004 Finland, Denmark, Sweden 2.4 2.1 2006 May March 2006 Sweden, Finland, Poland 2.6 2.3 2006 December October 2006 Poland, Finland, Sweden 2.8 2.2 2007 March 2007 Finland, Poland, Sweden 3.0 2.1
1) EU15 until April 2004; EU25 between May 2004 and December 2006; EU27 from January 2007 onwards. 2) Measured by the percentage change in the arthmetic average of the latest 12 monthly indices relative to the arithmetic average of the 12 monthly indices of the previous period. Source: Commission services.
Government budgetary position relation to the two criteria for budgetary discipline set in Article 104(2), namely on the government deficit The convergence criterion dealing with the and the government debt. Failure by a Member State government budgetary position is defined in the to fulfil the requirements under either of these criteria second indent of Article 121(1) of the Treaty as “the can lead to a decision by the Council on the existence sustainability of the government financial position: of an excessive deficit, in which case the Member this will be apparent from having achieved a State concerned does not comply with the budgetary government budgetary position without a deficit that convergence criterion (for further information on this is excessive as determined in accordance with procedure, see Box 4).15 Article 104(6)”. Furthermore, Article 2 of the Protocol on the convergence criteria states that this criterion means that “at the time of the examination the Member State is not the subject of a Council decision under Article 104(6) of this Treaty that an excessive deficit exists”.
The convergence assessment in the budgetary area is thus directly linked to the excessive deficit procedure which is specified in Article 104 of the Treaty and further clarified in the Stability and Growth Pact. The existence of an excessive deficit is determined in
15 The definition of the general government deficit used in this report is in accordance with the excessive deficit procedure, as was the case in previous convergence reports. In particular, interest expenditure, total expenditure and the overall balance include net streams of interest expenditure resulting from swaps arrangements and forward rate agreements. Government debt is general government consolidated gross debt at nominal value.
6 Chapter 1 Introduction
Box 4: The excessive deficit procedure 16 The excessive deficit procedure (EDP) is specified in Article 104 of the Treaty, the associated Protocol on the EDP and Council Regulation (EC) No 1467/97 on speeding up and clarifying the implementation of the EDP17, which is the “dissuasive arm” of the Stability and Growth Pact (SGP). Together, they determine the steps to be followed to reach a Council decision on the existence of an excessive deficit, which forms the basis for the assessment of compliance with the convergence criterion on the government budgetary position, and the steps to be followed to correct a situation of excessive deficit. According to Article 104(2), compliance with budgetary discipline is to be examined by the Commission on the basis of the following two criteria:
“(a) whether the ratio of the planned or actual government deficit to gross domestic product exceeds a reference value [specified in the Protocol as 3%], unless: — either the ratio has declined substantially and continuously and reached a level that comes close to the reference value; — or, alternatively, the excess over the reference value is only exceptional and temporary and the ratio remains close to the reference value; (b) whether the ratio of government debt to gross domestic product exceeds a reference value [specified in the Protocol as 60%], unless the ratio is sufficiently diminishing and approaching the reference value at a satisfactory pace”.
According to the Protocol, the Commission provides the statistical data for the implementation of the procedure. As part of the application of this Protocol, Member States have to notify data on government deficits, government debt and nominal GDP and other associated variables twice a year, namely before 1 April and before 1 October18. After each reporting date, Eurostat examines whether the data are in conformity with ESA9519 rules and related Eurostat decisions and, if they are, validates them.
The Commission is required to prepare a report if a Member State does not fulfil the requirements under one or both of the criteria given above (Article 104(3)). The report also has to take into account whether the government deficit exceeds government investment expenditure and all other relevant factors (considerations related to the medium-term economic and budgetary position of the Member State). These factors should be considered in the steps of the EDP leading to the decision on the existence of an excessive deficit only under the double condition that the deficit is close to the reference value and its excess over it is temporary. Special provisions are foreseen for pension reforms introducing a multi-pillar system including a mandatory, fully-funded pillar (for further details, see Box 1.5 of the December 2006 Convergence Report).
The next step in the procedure is the formulation by the Economic and Financial Committee of an opinion on this report within two weeks of its adoption by the Commission (Article 104(4)). If it considers that an excessive deficit exists or may occur, the Commission then addresses an opinion to the Council (Article 104(5)). On the basis of a Commission recommendation, the Council decides, after an overall assessment, whether an excessive deficit exists (Article 104(6)). Any such decision has to be adopted as a rule within four months of the reporting dates (1 April, 1 October).
When it decides that an excessive deficit exists, the Council has to issue a recommendation to the Member State concerned with a view to bringing that situation to an end within a given period, also on the basis of a Commission recommendation (Article 104(7)). The Council recommendation has to specify when the correction of the excessive deficit should be completed, namely in the year following its identification unless there are
16 Information regarding the excessive deficit procedure and its application to different Member States since 2002 can be found at: http://ec.europa.eu/economy_finance/about/activities/sgp/edp_en.htm. 17 OJ L 209, 2.8.1997, p. 6. Regulation as amended by Regulation (EC) No 1056/2005 (OJ L 174, 7.7.2005, p. 5). 18 Council Regulation (EC) No 3605/93 on the application of the Protocol on the excessive deficit procedure (OJ L 332, 31.12.1993, p. 7). Regulation as last amended by Regulation (EC) No 2103/2005, (OJ L 337, 22.12.2005, p. 1). 19 European System of National and Regional Accounts, adopted by Council Regulation (EC) No 2223/96 (OJ L 310, 30.11.1996, p. 1). Regulation as last amended by Regulation (EC) No 1267/2003 of the European Parliament and of the Council (OJ L 180, 18.7.2003, p. 1).
7 Convergence Report 2007 on Malta Technical annex
special circumstances, and has to include a deadline of six months at most for effective action to be taken by the Member State concerned. The recommendation should also specify that the Member State concerned has to achieve a minimum annual improvement of at least 0.5% of GDP as a benchmark in its cyclically-adjusted balance net of one-off and temporary measures.
If effective action has been taken in compliance with a recommendation under Article 104(7) and, compared with the economic forecasts in this recommendation, unexpected adverse economic events with major unfavourable consequences for government finances occur subsequent to its adoption, the Council may decide, on a recommendation from the Commission, to adopt a revised recommendation under the same article, which may notably extend the deadline for the correction of the excessive deficit by one year. Where it establishes that there has been no effective action in response to its recommendations, the Council adopts a decision under Article 104(8) on the basis of a Commission recommendation immediately after the expiry of the deadline for taking action (or at any time thereafter when monitoring of the action taken by the Member State indicates that action is not being implemented or is proving to be inadequate). The provisions of Article 104(9 and 11), on enhanced Council surveillance and ultimately sanctions in case of non-compliance, are not applicable to Member States with a derogation (that is, those that have not yet adopted the euro), which is the case of the Member States considered in this report.
When, in the view of the Council, the excessive deficit in the Member State concerned has been corrected, the Council abrogates its decision on the existence of an excessive deficit, on the basis of a Commission recommendation (Article 104(12)).
Exchange rate stability this technical annex is 27 April 2005 to 26 April 2007. The Treaty refers to the exchange rate criterion in the third indent of Article 121 as “the observance of the normal fluctuation margins provided for by the Long-term interest rates exchange-rate mechanism of the European Monetary The fourth indent of Article 121(1) of the Treaty System, for at least two years, without devaluing requires “the durability of convergence achieved by against the currency of any other Member State”. the Member State and of its participation in the exchange rate mechanism of the European Monetary Article 3 of the Protocol on the convergence criteria System being reflected in the long-term interest rate stipulates: “The criterion on participation in the levels”. Article 4 of the Protocol on the convergence exchange rate mechanism of the European Monetary criteria further stipulates that “the criterion on the System (…) shall mean that a Member State has convergence of interest rates (…) shall mean that, respected the normal fluctuation margins provided for observed over a period of one year before the by the exchange-rate mechanism of the European examination, a Member State has had an average Monetary System without severe tensions for at least nominal long-term interest rate that does not exceed the last two years before the examination. In by more than 2 percentage points that of, at most, the particular, the Member State shall not have devalued three best-performing Member States in terms of price its currency’s bilateral central rate against any other stability. Interest rates shall be measured on the basis Member State’s currency on its own initiative for the of long-term government bonds or comparable same period”. Based on the Council Resolution on securities, taking into account differences in national the establishment of the ERM II20, the European definitions”. Monetary System has been replaced by the Exchange Rate Mechanism II upon the introduction of the euro, For the assessment of the criterion on the convergence and the euro has become the centre of the mechanism. of interest rates, yields on benchmark 10-year bonds have been taken, using an average rate over the latest As in previous reports, the assessment of this criterion 12 months. The reference value is calculated as the verifies the participation in ERM II and examines simple average of the average long-term interest rates exchange rate behaviour within the mechanism. The of the three best-performing Member States in terms relevant period for assessing exchange rate stability in of price stability plus 2 percentage points. In March 2007, the reference value, derived from the average 20 97/C 236/03 of 16 June 1997, OJ C 236, 2.8.1997, p.5.
8 Chapter 1 Introduction
interest rate in Finland (3.9%), Poland (5.3%) and The additional factors are an important indicator that Sweden (3.8%), was 6.4%. the integration of a Member State into the euro area would proceed without major difficulties. As regards Additional factors the integration of financial markets, the focus is on compliance with the acquis communautaire in respect The Treaty in Article 121 also requires an of the financial sector, on main characteristics, examination of other factors relevant to economic structures and trends of the financial sector and on integration and convergence. These additional factors progress in financial integration. Integration of include financial and product market integration and product markets is assessed through trade, foreign the development of the balance of payments. The direct investment and a smooth functioning of the examination of the development of unit labour costs internal market. Finally, the situation and and other price indices, which is also prescribed by development of the current account of the balance of Article 121 of the Treaty, is covered in the chapter on payments is examined to ensure that the Member price stability. States joining the euro area are not subject to unsustainable external imbalances.
9
2. LEGAL COMPATIBILITY
2.1. Legal situation have to respect this principle and may not seek to influence the members of the decision-making bodies Following Malta’s independence in 1964, the Central of the national central banks in the performance of Bank of Malta (CBM) was established in April 1968 their tasks. The different features which make up independence may be grouped into three categories: on the basis of the Central Bank of Malta Act (1967). 21 It is a corporate body with a distinct legal personality. institutional, personal and financial independence. The CBM became an independent central bank In particular concerning personal independence, the pursuing price stability as its primary objective ESCB Statute contains specific provisions, for following amendments to the Act adopted in October example, on the term of office of the governor of a 2002. The CBM Act was amended twice in 2005. A national central bank and the grounds for his dismissal further Act (Act n° I of 2007) amending the CBM Act (Article 14.2 ESCB Statute). was adopted by Parliament on 28 February 2007, entering into force on the date to be established by the The CBM Act was already considered compatible Minister of Finance. This date should be the date of with the Treaty as regards independence in the 2006 the introduction of the euro in Malta. Convergence Report.
The decision-making bodies of the CBM are the Integration in the ESCB Governor and the Board of Directors. The sole The incompatibilities raised in the 2006 Convergence authority (and responsibility) to take decisions and to Report have been removed. The Act on the perform any function or duty or to exercise any power amendments to the Central Bank of Malta Act notably relating to monetary policy is vested in the Governor, repeals Articles 4(2)a, 17A, 17D, 19, 37(2) and (3), who, when performing this function, shall act in 39, 40, 41 as well as Article 43(3) and (4) of the initial accordance with the powers and duties conferred by Act. Moreover, a series of articles have been amended the Treaty and the ESCB Statute. The Governor may so as to take account of the respective roles and establish a Monetary Policy Advisory Council to competences assigned by the EC Treaty to the ECB, advise him on matters relating to monetary policy. ESCB and the EC Council. This concerns in particular Articles 15(2) on the holding and managing of foreign Objectives reserves, Articles 42 and 43(1) and (2) on the right to The primary objective of the CBM is to maintain authorise the issue of banknotes and the volume of price stability. The secondary objective of the CBM coins, Articles 15(1) and 37(1) on the monetary (Article 4(1)) has been amended and fully reflects the functions, operations and instruments of the ESCB, ESCB’s secondary objective. Article 52a on the imposition of sanctions and Article 22 on the financial provisions related to the ESCB.
Independence Prohibition of monetary financing According to Article 108 of the Treaty neither a national central bank nor any member of its decision- In line with the prohibition of monetary financing making bodies shall, when exercising the powers and (Article 101(1) of the Treaty), the CBM shall not carrying out the tasks and duties conferred upon them grant overdrafts or any other type of credit facility to by the EC Treaty and the ESCB Statute, seek or take Community institutions or bodies, to the government instructions from Community institutions or bodies, or any public authority, to bodies governed by public from any government of a Member State or from any law, public undertakings or government-owned other body. Inversely, the Community institutions and bodies and the governments of the Member States 21 See European Commission, Convergence Report 2004, p. 10-11.
10 Chapter 2 Legal compatibility
corporations of any Member State. Moreover, the 2.2. Assessment of compatibility CBM shall not directly purchase debt instruments of such entities (Article 27(1)). Legislation in Malta is compatible with the requirements of the EC Treaty and the ESCB Statute. However, an imperfection subsists in this respect: Article 17(1)g of the revised Act (Article 15(1)g of One residual imperfection subsists in the Central the initial Act) offers the possibility for the CBM of Bank of Malta Act with respect to the prohibition of providing lending to any Maltese credit institution in monetary financing. order to safeguard financial stability and in other exceptional circumstances. It should be ensured, e.g. through a specific safeguard clause, that the CBM does not possibly end up bearing financial costs to be borne by the state. Otherwise monetary financing would be involved, which would be contrary to Article 101 of the Treaty. Moreover, the CBM's financial independence could be put at risk.
11
3. PRICE STABILITY
3.1. Respect of the reference value inflation hovered around 3.5%. When the impact of higher oil prices ebbed away, inflation dropped The 12-month average inflation rate for Malta, which markedly to below 1% at the end of 2006 and it has is used for the convergence assessment, has fluctuated stayed close to that level since then. Since November around the reference value for the past years. 2006, Malta has been the EU Member State with the 12-month average inflation has been at or slightly lowest HICP inflation rate. Apart from the significant below the reference value since July 2005 except for base effects in energy inflation, the decline reflects a the period May – October 2006. In March 2007, the drop in prices of clothing and footwear and air reference value was 3.0%, calculated as the average of transport (following the arrival of low-cost airlines in the 12-month average inflation rates in the three best- November 2006). performing Member States (Finland, Poland and Sweden) plus 1.5 percentage points. The Chart 1. Malta: Inflation criterion since May 2004 corresponding inflation rate in Malta was 2.2%, i.e. 6 (percent, 12-month moving average)
0.8 percentage point below the reference value. 5
4 3.2. Recent inflation developments 3 Since 1999, HICP inflation in Malta22 has been moderate with annual averages between 2 and 3%. At 2 the same time, Malta's inflation has been 1 Malta characterised by marked intra-year volatility Reference value reflecting the high sensitivity of the small and open 0 economy to external price shocks and exchange rate 2004 2005 2006 2007 fluctuations. Having stayed close to 2% since 2002, Sources: Eurostat, Commission services' Spring 2007 Forecast inflation picked up in 2004, mainly due to indirect tax increases, but it returned to around 2% at the beginning of 2005. In autumn 2005, inflation increased again and more considerably, reflecting a Chart 2. Malta: HICP inflation strong rise in energy prices related to higher oil prices. 6 (y-o-y percentage change) Between October 2005 and September 2006, headline 5
22 In the context of compliance monitoring and quality 4 assurance, Eurostat has been reviewing the statistical practices used to compile the HICP for Malta against 3 HICP methodology and other guidelines and good practices in the field of consumer price indices. 2 Eurostat considers that in general the methods used for 1 Malta producing the Maltese HICP are satisfactory. The Euro area Maltese data passes all standard HICP validation tests, 0 and should be considered broadly comparable to the 1999 2000 2001 2002 2003 2004 2005 2006 HICPs of other EU countries. While the accuracy and Source: Eurostat reliability of the HICP are judged as generally adequate, some points for improvement are suggested. The compliance report is available under http://epp.eurostat.ec.europa.eu/pls/portal/docs/page/pg p_ds_hicp/TAB61582098/information%20note%20on %20cm%20-%20malta%202006-10.pdf
12 Chapter 3 Price stability
Table 2. Malta: Components of inflation1) weights (percentage change) in total 2001 2002 2003 2004 2005 2006 Mar-07 2007 HICP 2.5 2.6 1.9 2.7 2.5 2.6 2.2 1000 Non-energy industrial goods 0.2 0.4 -1.3 1.5 1.7 1.7 1.4 321 Energy 0.3 3.7 2.2 5.9 15.9 17.1 9.6 56 Unprocessed food 6.6 0.6 2.3 -1.0 2.2 2.2 2.8 79 Processed food 3.0 5.1 1.5 4.5 1.5 1.6 1.8 143 Services 3.7 3.6 4.6 3.2 2.3 1.4 1.4 401 HICP excl. energy and unproc. food 2.3 2.7 1.9 2.8 2.0 1.6 1.5 865 1) Measured by the arithmetic average of the latest 12 monthly indices relative to the arithmetic average of the 12 monthly indices in the previous period. Sources: Eurostat, Commission services.
Core inflation (measured as HICP inflation excluding The fiscal stance, as measured by changes in the energy and unprocessed food) has remained contained cyclically-adjusted primary balance, has been at an average of 2% in 2005 and 1.6% in 2006, though tightened in 2004 and 2005 and was roughly neutral this masks considerable intra-year volatility amid in 2006. Fiscal impulses have thus not been a driver fluctuations in sub-items such as food, clothing, of inflation. A moderate decline of the cyclically- accommodation and administered prices (water). At adjusted primary surplus is expected for 2007, though the end of 2006, this measure of core inflation fell to against the background of a still negative output gap. historically low levels below 1% before rebounding to Exchange rate stability and a credible monetary policy 1.2% in the first quarter of 2007. Moderate core have also contributed to keep inflation at relatively inflation dynamics suggest that underlying low levels. inflationary pressures have remained limited, against the background of a negative output gap and low Wages and labour costs wage pressures. In particular, there have been no signs of second-round effects from energy prices so far, Inflationary pressures from the labour cost side appear suggesting that inflationary expectations remain well- contained at present, amid slow growth of both wages anchored. and labour productivity. Following a few years of deceleration (from 5.8% in 2001 to slightly above 1% in 2005 and 2006), annual growth of nominal 3.3. Underlying factors and compensation per employee is expected to recover sustainability of inflation moderately to some 1.6% this year. Labour productivity has recorded strong cyclical fluctuations Macroeconomic policy-mix and cyclical stance (as GDP volatility was not directly translated into employment) around a low trend rate. Productivity The Maltese economy is estimated to be operating fell alongside real GDP in 2003 and grew at around below potential, following two years of negative or 1.2% annually in the following two years. A slight flat real GDP growth in 2003 and 2004, and despite a pick-up to around 2% is estimated for 2006 and relatively robust recovery to a growth rate of around 2007. Together, wage and 3% in 2005 and 2006. Real GDP growth is expected to stay around 3% in 2007 and 2008, which would Chart 3. Malta: Inflation, productivity and wage trends narrow but not close the negative output gap. While in 10 y-o-y % change 2005 the recovery was based on relatively robust 8 growth in both private and public investment and a 6 revival of private consumption, a rebound of exports 4 was an additional impetus in 2006. The main drivers 2 in 2007 should be foreign investment and strong 0 private consumption stemming from a lower income -2 tax and cash de-hoarding in anticipation of the euro -4 1999 2000 2001 2002 2003 2004 2005 2006 changeover. Unemployment has been stable at around Productivity (real GDP per person employed) 7.4% since 2004, but is expected to decrease in the Nominal compensation per employee Nominal unit labour costs period ahead. Price deflator private consumption Source: Commission services
13 Convergence Report 2007 on Malta Technical annex
Table 3. Malta: Other inflation and cost indicators (annual percentage change) 2001 2002 2003 2004 2005 2006 20071) Private consumption deflator Malta2.42.10.62.42.62.01.4 Euro area2.31.82.12.02.02.01.8 Nominal compensation per employee Malta5.82.83.92.51.11.21.6 Euro area2.72.72.82.51.92.22.6 Labour productivity Malta -2.8 1.4 -3.3 1.2 1.2 2.0 2.1 Euro area0.50.40.81.60.91.41.4 Nominal unit labour costs Malta 8.9 1.4 7.4 1.2 -0.1 -0.7 -0.5 Euro area2.22.42.00.91.00.91.2 Imports of goods deflator Malta -4.2 2.5 -5.7 -3.3 3.1 12.2 1.0 Euro area 0.2 -2.9 -2.2 1.5 4.0 4.7 0.7
1) Commission services' Spring 2007 Forecast. Source: Commission services.
productivity developments in 2000-2004 have yielded measured by the import of goods deflator in the somewhat volatile results in terms of nominal unit national accounts, have been favourable to labour costs (ULC). Since 2005, ULC have been disinflation in 2003 and 2004, with decreases of 5.7 decreasing, and slightly negative growth is expected and 3.3%, respectively. Import price inflation also in 2007. strengthened to around 3% in 2005 and is estimated to have increased further in 2006, thus generating Negative ULC growth confirms that wage agreements upward pressure on headline inflation.23 in the private sector have in the recent past tended to broadly take account of productivity concerns. It also Import price fluctuations have been heavily suggests that no second-round effects from recent influenced by global oil price developments, with energy price increases through the wage-setting year-on-year fuel price inflation accelerating from process have materialised so far. Public sector wage 12% on average in 2005 to some 21% on average discipline has been fostered through a multi-year during the first 9 months of 2006, though followed by collective agreement concluded in late 2005. Wage a 10% year-on-year drop since November. High agreements in private sector reflect a need to regain commodity prices have been partly counterbalanced competitiveness. Flexibility of the wage setting by favourable effects from trade liberalisation, process in Malta is somewhat diminished by partial including in the context of EU accession, and wage indexation (cost-of-living adjustment based on increased global market integration, which may have the "social wage", which is lower than the average held down import price inflation in some sectors (e.g. wage), although indexation can be waived at firm food, clothing, furniture). Exchange rate level. Preserving wage discipline in both the public developments have also had a bearing on import price and private sector will be important to contain dynamics over the past years. The nominal effective spillover risks from temporary factors affecting exchange rate of the lira, measured against a group of headline inflation.
23 Import prices However, it should be noted that the current statistics suggesting a surge in the import deflator by 12 percent Given Malta's small size and high degree of openness, in 2006 is surrounded by some uncertainty due to the imported goods account for a large share of the specifics of such a small economy (non-availability of consumer basket. Import price developments, as comparable products for one-off imports, new products, etc.).
14 Chapter 3 Price stability
40 trade partners, appreciated steadily by around 10% prices, given the energy-intensive desalination process between 2000 and 2004, dampening import price used to generate drinking water. The combined impact dynamics. The effective exchange rate broadly of a drop in energy and water inflation – resulting stabilised in 2005 and 2006, thus remaining roughly from both strong base effects and falling prices of fuel neutral with regard to import prices. in autumn 2006 - contributed by almost 2 percentage points to the sharp decline in headline inflation in October and November 2006. In the first quarter of Chart 4. Nominal effective exchange rate: MTL * 2007, energy and water contributed to inflation (monthly averages, index 1999 = 100) 115 negatively, by about -0.3 percentage point.
110 VAT and excise increases, partly related to EU 105 accession, had a relatively strong impact on inflation in Malta in 2004, but Malta's inflation profile since 100 2005 has not been appreciably influenced by changes in indirect taxes. 95 * vs. 40 trading partners 90 Medium-term prospects 2000 2001 2002 2003 2004 2005 2006 Inflation performance in 2007 will mainly reflect the Source: Commission services path of prices for energy and related products. As base effects related to strong price increases in these Administered prices and taxes categories in late-2005 subside towards the end of 2007, headline inflation is expected to move back The share of administered prices in the Maltese HICP towards rates more consistent with medium-term basket is relatively low, reflecting inter alia a trends. The Commission 2007 Spring Forecast comparatively small share of energy products in the projects a deceleration of annual average HICP basket. Still, Malta's inflation profile in the last years inflation from 2.6% in 2006 to 1.4% in 2007 and an has been strongly shaped by developments in increase in 2008 to 2.1%. regulated prices for energy and related products, as pent-up price pressures have been released. In Risks to this inflation outlook appear broadly particular, electricity and water supply prices were balanced. The main risks are related to energy prices increased significantly in January 2005 through the and are two-sided. Apart from the development of oil imposition of a "surcharge"24, with a particularly prices, uncertainties arise as regards the planned sharp hike in November 2005. expiry of the energy surcharge scheme in late 2007,
although no significant impact is expected. The on- Due to the introduction of the surcharge, the impact of going liberalisation of the energy sector in Malta higher oil prices on inflation was more pronounced in could result in downward pressure on energy prices Malta than in other EU Member States, despite a lower share of energy in the HICP basket (at some Consumer prices in Malta are some 70-75% of the EU 6%, compared to around 9% in the euro area). During average. This suggests some potential for some the first 10 months of 2006, electricity prices were gradual further price level convergence in the long- 37% higher than one year before and energy term, as income levels (currently abut 70% of the accounted for around 1.5 percentage points of Malta's EU25 average in PPS) rise towards the EU average. HICP inflation. A 30-percent increase in the administered price of water supply in November Medium-term inflation prospects will also depend 2005, which added another 0.2 percentage point to strongly on wage and productivity developments as headline inflation, was also related to higher oil well as the competitive environment. Measures should
24 be taken (including in the field of education and A surcharge on electricity and water prices was labour market regulation) in order to prevent labour introduced in January 2005 to reflect the development shortages and skill mismatches, in particular in the of oil price. In the previous regime, the prices of electricity and water had been kept constant and all light of some upcoming large investment projects losses resulting from higher international oil prices were (e.g. "Smart City – Malta"). Advancing structural absorbed by state-owned electricity and water providers. reforms to improve the functioning of product The surcharge is currently adjusted bi-monthly in light markets (in particular utilities) is warranted with a of developments in oil prices.
15 Convergence Report 2007 on Malta Technical annex
view to price developments. Fiscal discipline will also be important to stem inflationary risks as cyclical conditions improve.
16
4. GOVERNMENT BUDGETARY POSITION
4.1. The excessive deficit procedure for place. Since then, the deficit-to-GDP ratio has Malta25 progressively declined, reaching 2.6% of GDP in 2006. The 2006 outcome is 0.1 percentage points better than the official target of 2.7% of GDP set in In July 2004, the Council decided that Malta was in the January 2006 update of the convergence excessive deficit, based on a deficit of 9.7% of GDP programme. The primary balance, after reaching a in 2003 and a rising debt ratio, which stood at 72% of through of -6.5% of GDP in 2003, turned into a GDP in 2003. At the same time, the Council issued a surplus in 2005 and stood at 1.1% in 2006. Interest recommendation to correct the excessive deficit. In expenditure was relatively stable in a range between particular, Malta was recommended to take action in a 3.4% and 3.8% of GDP during this period. medium-term framework in order to bring the deficit below 3% of GDP by 2006 in a credible and The revenue-to-GDP ratio followed an upward trend sustainable manner, in line with the Council Opinion between 2000 and 2005, increasing by 8 percentage on the May 2004 Convergence Programme. The points, on account of both new and higher taxes and Council endorsed the following intermediate targets in response to the government's drive to achieve a for the general government deficit: 5.2% of GDP in more efficient tax collection. In 2006, total revenue 2004, 3.7% in 2005 and 2.3% in 2006. Malta was also declined marginally in relation to GDP and stood at recommended to bring the rise in the debt ratio to a 42.7% mainly reflecting a fall in both social halt in 2005. contributions and capital transfers. Nevertheless,
capital transfers rose substantially in 2004 and 2005, In its Opinion on the December 2006 update of the supported by financial inflows from the Italian Convergence Programme, the Council noted that the financial protocol26 and EU funds. Total expenditure debt ratio seemed to be diminishing at a satisfactory as a% of GDP increased until 2003, but declined pace towards the 60% of GDP reference value and thereafter. Rising current spending - mainly as a result that the programme was consistent with a correction of higher final consumption expenditure and social of the excessive deficit by 2006. In view of these transfers - underpinned the upward trend in total developments and the Commission services' Spring expenditure up to 2003. Capital spending also 2007 Forecast, the Commission considers that the contributed to the rise in expenditure primarily excessive deficit has been corrected with a credible reflecting spending related to the building of the and sustainable reduction of the deficit below 3% of Mater Dei hospital. The decline in total expenditure in GDP and the rise in the debt to GDP ratio has been 2004 occurred on the back of a fall in capital outlays decreasing since 2004. The Commission is therefore as current expenditure continued to rise. In 2005, the recommending to the Council to abrogate the decision fall in the general government expenditure ratio to on the existence of an excessive deficit for Malta. GDP was due to a decline in current spending which more than offset higher total capital expenditure. In 4.2. Developments until 2006 2006, the further decline in total expenditure ratio reflected both lower current spending and public Over the 2000-2006 period, the general government investment, the latter mainly reflecting constraints in deficit averaged around 5.5% of GDP reaching a high the capacity to absorb EU funds. of 10% of GDP in 2003, when a one-off expenditure- increasing transaction amounting to some 3% of GDP Recourse to one-off and other temporary measures in relation to the restructuring of the shipyards took was substantial since 2003. Apart from 2003, one-off measures in the other years under consideration were 25 All documents related to the excessive deficit procedure for Malta can be found at: http://ec.europa.eu/economy_finance/about/activities/sg 26 Co-operation agreement signed between Italy and Malta p/procedures_en.htm. providing grants to finance public projects in Malta.
17 Convergence Report 2007 on Malta Technical annex
deficit-reducing operations consisting mainly of sale GDP in 2007. This suggests that the relatively high of land averaging around 1% of GDP each year. The economic growth and the progressive closing of the structural deficit (i.e. cyclically-adjusted deficit net of output gap anticipated for 2007 are not being utilised one-off and other temporary measures) improved fully to speed up the pace of adjustment. from a high of 6.4% of GDP in 2003 to 3.8% in 2005. In 2006, the structural deficit declined further to 2.7% The December 2006 update of the convergence of GDP. programme covers the period from 2006 to 2009. The budgetary strategy outlined in the update aims at As a result of the deficit recorded in successive years, reducing the deficit below the 3% of GDP reference the general government debt moved from a position value in 2006 and at pursuing fiscal consolidation below 60% of GDP in 2000 to one substantially above thereafter, to a broadly balanced budget by 2009.27 the reference value. Specifically, the debt ratio The medium–term objective (MTO) for the budgetary increased from around 56% of GDP in 2000 to position is a balanced position in structural terms. slightly below 74% of GDP in 2004. The acceleration According to the December 2006 programme, the in debt accumulation which occurred in 2003 reflects MTO will be achieved beyond the programme period. a one-off transaction as government took over debt incurred in the past by the shipyards as part of The Commission services' Spring 2007 forecast restructuring this sector. However, starting from 2005 projects general government debt of 65.9% of GDP the debt ratio followed a downward path reaching for 2007, down from 66.5% of GDP recorded in the around 66.5% of GDP in 2006. During these years, previous year. According to the December 2006 stock-flow adjustments – specifically, proceeds from convergence programme, the debt ratio is foreseen to privatisation - dampened the rise in debt. In particular, follow a downward path between 2007 and 2009, the decline in the general government debt in 2006 when it is expected to reach 59.4% of GDP. was to a large extent due to substantial privatisation proceeds amounting to around 3.5% of GDP. In its Opinion of 27 February 2007 on the December 2006 update of the Convergence Programme, the 4.3. Medium-term prospects Council noted that, in a context of strong growth prospects, the programme envisaged adequate The Budget for 2007 was approved by Parliament on progress towards the MTO but that there were risks to 17 November 2006. The main measures presented in the achievement of the budgetary targets after 2007. the Budget include a reform of the personal income In particular, while in the years following the tax regime, a new licensing system for gaming correction of the excessive deficit, the pace of machines, lower social contributions for certain adjustment towards the MTO implied by the categories of part-time employment, tax deductions programme was broadly in line with the Stability and for parents utilising the services of childcare facilities, Growth Pact, there were some risks to the budgetary a reduction in the airport tax, an energy benefit aimed projections in the programme, especially with regard at alleviating the cost of energy to low-income to the assumed favourable macroeconomic households and improvements in certain social assumptions in 2008 and 2009. The Council invited benefits. The Budget also announced the Malta to pursue the planned progress towards the securitisation of certain government property MTO, ensure that the debt-to-GDP ratio was reduced (estimated at around 1 percentage point of GDP) to accordingly and to make further progress in the design finance payment for expropriated land. The 2007 and implementation of the healthcare reform in order Budget targets a further decline in the general to improve the long-term sustainability of public government deficit to 2.3% of GDP in 2007, which finances. was subsequently improved to 1.9% of GDP in the April 2007 fiscal notification. Compared to the April 2007 fiscal notification, the Commission services' Spring 2007 forecast projects a slightly more cautious adjustment to 2.1% of GDP in 2007, primarily due to lower revenue from social contributions as compared 27 The successive updates of the convergence programme to the projections of the Maltese authorities. and the assessments by the Commission and Council can be found at: http://ec.europa.eu/economy_finance/about/activities/sg The structural deficit is projected to improve p/main_en.htm. marginally from 2.7% of GDP in 2006 to 2.6% of
18 Chapter 4 Government budgetary position
Table 4. Malta: Budgetary developments and projections (as percentage of GDP unless otherwise indicated) Outturn and forecast (1) 2000 2001 2002 2003 2004 2005 2006 2007 General government balance -6.2 -6.4 -5.5 -10.0 -4.9 -3.1 -2.6 -2.1 - Total revenues 34.9 36.7 38.2 38.6 41.9 42.9 42.7 42.2 - Total expenditure 41.0 43.1 43.8 48.6 46.8 46.0 45.2 44.3 Of which: - Interest expenditure 3.6 3.4 3.6 3.5 3.7 3.8 3.7 3.3 - Current primary expenditure 33.6 36.4 36.5 37.8 39.0 37.9 37.6 36.6 - Gross fixed capital formation 4.2 3.7 4.5 5.1 2.1 5.3 4.6 5.2 Primary balance -2.5 -3.1 -1.9 -6.5 -1.2 0.7 1.1 1.2 p.m. Tax burden 28.2 30.4 31.9 31.8 33.8 34.5 34.9 35.2 Cyclically-adjusted balance -7.8 -6.9 -6.2 -9.2 -3.6 -2.2 -2.0 -1.9 One-off and temporary measures - - - -2.9 0.7 1.7 0.7 0.6 Structural balance (2) - - - -6.4 -4.3 -3.8 -2.7 -2.6 Structural primary balance - - - -2.9 -0.6 0.0 1.0 0.8 Government gross debt 56.0 62.1 60.8 70.4 73.9 72.4 66.5 65.9 p.m. Real GDP (% change) 6.4 -1.1 1.9 -2.3 0.4 3.0 2.9 3.0 p.m. Output gap 5.5 1.4 2.0 -2.1 -3.4 -2.5 -1.5 -0.6 p.m. GDP deflator (% change) 1.7 2.9 2.7 4.6 1.4 2.4 2.6 2.3 Convergence programme 2005 2006 2007 2008 2009 General government balance -3.2 -2.6 -2.3 -0.9 0.1 Primary balance 0.8 1.1 1.1 2.5 3.2 Structural balance (2) (3) -3.8 -2.9 -2.0 -1.0 -0.4 Government gross debt 74.2 68.3 66.7 63.2 59.4 p.m. Real GDP (% change) 2.2 2.9 3.0 3.1 3.1
(1) Commission services’ Spring 2007 Forecast. (2) Cyclically-adjusted balance excluding one-off and other temporary measures. (3) Commission services’ calculations on the basis of the information in the programme. One–off and other temporary measures according to the programme are 1.6% of GDP in 2005, 1.1% of GDP in 2006, 0.2% of GDP in 2007, 0.2% of GDP in 2008 and 0.2% of GDP in 2009, all deficit-reducing. Sources: Eurostat, Commission services and December 2006 update of the convergence programme.
19
5. EXCHANGE RATE STABILITY
On 2 May 2005, the Maltese lira entered ERM II at Chart 5. MTL: Spread vs central rate the previous trading day’s ECB reference rate of 0.2 0.4293 MTL/EUR, with a standard fluctuation band (as percent, daily values) of ±15%. Upon joining ERM II, the Maltese authorities unilaterally committed to maintain the lira exchange rate at the central rate. At the time of the adoption of this report, the lira has been participating 0.1 in ERM II for 24 months.
Before ERM II entry, Malta had followed a basket peg since the 1970s. Within this regime, the only exchange rate realignment occurred in 1992, when the 0.0 lira was devalued by 10% against the basket, in May-05 Sep-05 Jan-06 May-06 Sep-06 Jan-07 Sources: ECB, Commission services response to devaluations by major trade partners and competitors in the context of the ERM crisis. The last basket adjustment occurred in August 2002, raising Chart 6. Exc hange rates: MTL/EUR the share of the euro in the basket to 70%, with the (monthly averages) US dollar and British pound accounting for the 0.46 remaining share at 10 and 20%, respectively. At the ERM II time of ERM II entry, the lira was re-pegged to the 0.44 euro. This step did not affect the external value of the lira. 0.42
Since mid-2003, the lira stayed very close to its future 0.40 central rate, with monthly average deviations smaller than 0.8%. During its participation in ERM II, the lira 0.38 has exhibited no fluctuations against the central rate, 1999 2000 2001 2002 2003 2004 2005 2006 save for two minor technical deviations on the Source: ECB stronger side of the band, with a maximum deviation of 0.12% recorded on the first day of ERM II participation. Chart 7. Mal ta : 3 -M Mi bor s pread to 3-M Euribor (monthly values, basis points) Additional indicators do not point to pressures on the 300 exchange rate. The Central Bank of Malta (CBM) is 250 under a legal obligation to hold at least 60% of its 200 currency and deposit liabilities as foreign currency 150 reserves, thus ensuring a significant reserve buffer. In 100 practice, despite some fluctuations, the reserve cover 50 has consistently exceeded 100% of liabilities. At the 0 end of February 2007, reserves stood at 103% of -50 currency and deposit liabilities, equivalent to around -100 132% of the monetary base. 1999 2000 2001 2002 2003 2004 2005 2006 Source: Eurostat
20 Chapter 5 Exchange rate stability
The CBM closely monitors reserve developments in 2005, the policy interest rate differential between setting policy interest rates. Following significant Malta and the euro area has narrowed significantly, monetary easing between 2001 and 2003, mirroring from 125 to currently 25 basis points. The CBM developments in the countries represented in the slowed the pace of policy rate convergence through pegging basket, the CBM left its main policy rate on three 25 basis point rate hikes in May and October hold between September 2003 and April 2005 at a 2006 and in January 2007 with a view to ensuring level of 3%, i.e. 100 basis points above euro area stable foreign reserves and providing sufficient rates. In view of adverse reserve developments since support to the exchange rate peg. Spreads on Maltese late-2004, reflecting pressures on the current account money market rates vis-à-vis the euro area, which had as well as portfolio shifts by investors, the CBM hovered around 80-90 basis points until spring 2005, raised rates by 25 basis points in April 2005. Together widened in line with the interest rate hike in April with ERM II entry in May, this served to underpin 2005, but have narrowed to about 30 basis points investor sentiment and restore reserve stability. Since currently in tandem with policy rate convergence. the start of monetary tightening by the ECB in late-
21
6. LONG-TERM INTEREST RATES
Long-term interest rates in Malta used for the Chart 8. Malta: Long-term interest rate criterion convergence examination reflect secondary market 7 (percent, 12-month moving averages) yields on a basket of benchmark government bonds.
The Maltese 12-month moving average long-term 6 interest rate relevant for the assessment of the Treaty criterion has progressively declined over the whole 5 assessment period, reflecting a global decline in bond yields as well as a decreasing country risk premium. 4 In March 2007, the reference value, given by the Malta average of long-term interest rates in Finland, Poland Reference value and Sweden plus 2 percentage points stood at 6.4%. 3 2004 2005 2006 The 12-month moving average of the yield on ten- Sources: ECB, Eurostat, Commission services year Maltese benchmark bond stood at 4.3%, 2.1 percentage points below the reference value. Chart 9. Malta : Long-term interest rates At the beginning of 2001, Malta had the lowest long- (percent, monthly values) term interest rate among the new Member States. 7 Since then, Maltese long-term interest rates have 6 declined further towards euro area levels, albeit not on 5 a continuous path. Maltese long-term interest rates 4 decreased by around 150 basis points during the period of monetary easing between 2001 and autumn 3 2003, and subsequently remained stable at a level of 2 Malta Euro area 4.7% through mid-2005. This has implied some 1 fluctuation in spreads vis-à-vis the euro area, with 0 spreads dropping to a low of around 25 basis points in 2001 2002 2003 2004 2005 2006 Sources: ECB, Eurostat mid-2004 and widening to around 135 basis points by mid-2005. Spreads recorded a broad narrowing trend since then, reflecting both a moderate decrease in Maltese long-term rates and rising yields in the euro area. Having dropped to around 4.4% in August 2005, Maltese long-term rates recorded a further slight decrease in spring 2006, but increased at the beginning of 2007. Yield spreads vis-à-vis the euro area narrowed to a low of around 20 basis points in spring 2006, widened moderately to around 50 basis points in late 2006 and narrowed back to around 30 basis points in the first quarter of 2007.
22
7. ADDITIONAL FACTORS
7.1. Financial market integration concentration in terms of CR5 ratio30 of 75% would not be unusual in such a small market, domestic Reflecting its history as a regional financial centre, lending is de facto dominated by only two institutions. Malta’s financial system is substantially inter-linked There was also an increase in the number of licensed with the financial systems of other countries, both in insurance companies, insurance managers and and outside of the EU, via the establishment of affiliated insurance companies as well as a rapid financial intermediaries and the provision of cross- growth of investment funds in 2005. However, border services. Over the past decade, Malta has insurance and investment funds are still of minor moved from being an offshore to an onshore importance when compared to the banking system and jurisdiction by reforming its finance sector legislation private pension funds are just developing. in line with international best practice. All offshore licences terminated in 2004. Compliance with the The growth rate in domestic credit picked up to 9% acquis communautaire in the field of financial over 2006, as negative net lending to the central services was already broadly achieved on accession government compensated only partly a significant and the transposition process of legislation adopted 15% rise in claims on other residents, which reflected under the Financial Services Action Plan is close to mainly an increase in household borrowing for house completion.28 purchases and associated borrowing by the construction sector. According to the Central Bank of Malta's financial sector is well-developed in relation Malta, the share of foreign currency loans in domestic to its stage of economic development.29 Bank lending has increased over the past years, but was still intermediation is predominant, but activities of other limited at 8% at the end of 2006. Moreover, financial intermediaries are developing also. In terms exchange-rate risk for the economy should be of GDP, the value of outstanding credit in terms of mitigated by the domestic currency denomination of GDP exceeds the euro area average, while the central government debt and the fact that net foreign importance of the Maltese capital market for private assets of deposit money banks and international sector funding remains limited despite the relatively banking institutions have either stabilised or increased high value of outstanding domestic fixed-income over the past years. Malta's capital markets remain securities and stock market capitalisation compared to relatively small and illiquid. The decline of the the EU 10 average. Maltese stock market since March 2006 had a negative impact on trading activity, which was mostly The banking sector expanded considerably in 2005, as concentrated in bank equities. The number of actively new licences were issued to a number of credit and traded corporate bonds was also very limited. financial institutions and 29 banks from other Secondary market turnover fell also for government Member States were authorised to provide cross- bonds, which dominate the fixed income market, and border services in Malta. While the market share of for which the central bank acts as market maker. foreign owned credit institutions is still a bit lower than for the EU10 average, and the degree of The importance of adequate supervisory structures is heightened by Malta's role as a regional financial centre and the activity of foreign banks within the
28 system. Regulatory and supervisory responsibilities See: Transposition of FSAP Directives - State of play as have been consolidated in the Malta Financial of 15/01/2007. http://ec.europa.eu/internal_market/finances/docs/action Services Authority (MFSA) since 2002. The MFSA plan/index/070124_annex_b_en.pdf 29 Malta's GDP per capital level (PPS) stood at 69% of the EU25 average in 2005, which is the fourth highest level 30 The CR5 concentration ratio is defined as the after Cyprus (83%), Slovenia (80) and the Czech aggregated market share of five banks with the largest Republic (73%). market share.
23 Convergence Report 2007 on Malta Technical annex
Chart 10a. Malta: Structure of financial system Chart 10b. Malta: Foreign ownership and relative to EU-10 and Euro area concentration in the banking sector in 2005 CR5 ratio (in % of total assets) 250 (in percentage of GDP) 80 Share of foreign institutions as % of total assets of Debt securities (end-2005) 200 70 domestic credit institutions Stock market capitalisation (end-2006) Total bank loans (end-2005) 60 150 50
100 40 30 50 20 10 0 0 Malta EU10 Euro area Malta EU10 Euro area Sources : European Banking Federation, Eurostat, ECB (including own calculations and estimates) Source : ECB: EU Banking Structures (2006) (including estimates)
Chart 10c. Malta: Domestic credit expansion Chart 10d. Malta: Share of foreign currency loans (y-o-y percentage change) (in percentage of domestic credit)
20 9 15 8 10 7 5 6 0 5 -5 4 -10 Domestic credit 3 -15 Central government 2 -20 Other 1 -25 0 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Source : Central Bank of Malta Source : Central Bank of Malta supervises the banking, securities and insurance few sectors increases the exposure of the economy to sectors, but the central bank retains responsibility for asymmetric shocks determined by the evolution of monitoring the financial system’s overall stability. international markets. Nonetheless, there is evidence These institutional changes have been accompanied of progress in terms of the diversification of economic by measures to facilitate cross-border co-operation activities, namely with the expansion of other services between Malta and foreign supervisory bodies, and sectors like financial services and ICT and the build- the MFSA has continued to increase the number of up of clusters in manufacturing sectors like bilateral and multilateral Memoranda of pharmaceuticals. Understanding with other regulators over 2006. Malta is among the most open economies in the EU25 and in the euro-area. The trade openness ratio has 7.2. Product market integration decreased during the first half of the decade but this evolution is largely driven by cyclical developments, The high degree of openness and the intensity of namely the downturn at the beginning of the decade in integration with the EU are outstanding features of the the tourism industry and in the semiconductors Maltese economy. This promotes competition sectors, which dominate Malta’s trade. Over time the pressure across the economy and therefore ensures EU25 has been reinforcing its position as Malta's that firms are given the right incentives to improve main trading partner. In 2005, the weight of extra-EU their level of efficiency. However, the small size of trade in Malta's total trade (around 32%) was lower the Maltese economy hampers the scope for the than the weight of extra-EU trade in the total trade of diversification of production activities and leads to a the EU25 (36%). Moreover, trade integration with the high degree of trade specialisation in a small number euro-area is particularly well advanced. In 2005, 77% of sectors, notably electronics (in particular of Malta's intra-EU trade flows were with euro-area semiconductors) and tourism. Such dependence on a Member States.
24 Chapter 7 Additional factors
With respect to the composition of trade, the The relative underdevelopment of the medium-high relatively low share of intra-industry trade in total technology manufacturing sectors when compared to manufacturing trade with the EU25 is striking, the EU25 and the dependence on the electronics and reflecting the high level of specialisation. tourism sectors are important features of the Manufacturing trade is dominated by the electronics integration of Malta in the EU economy. A process of industry. However, this is largely driven by the restructuring towards other innovation-driven sectors presence of one large manufacturer affiliated to a and activities to reduce the economy’s exposure to the multinational company of semi-conductors.31 The fluctuations of these sectors and to prevent pattern of trade specialisation reveals considerable competitiveness strains from the increasing duality with respect to the level of technology competition pressure in low technology sectors from intensity.32 While there is a dominance of high lower-cost economies is underway. However, the technology sectors (largely due to the semiconductors conditions for such a successful and sustained sector), the other sectors where the country has transition are not yet fully in place. comparative advantage are mostly of low and medium-low technology, like for example clothing. Malta's innovation performance remains well below The relatively high transport costs contribute to the EU average.35 Recent survey data show that while explaining the importance of the services sectors in 42% of EU27 enterprises are actively engaged in trade flows, namely tourism and financial services. In innovation, only 21% of Maltese enterprises do so.36 2005, the share of services in total trade was around R&D spending is still well below the EU average 30% compared to 22% in the EU25. level, despite the ongoing efforts led by the authorities to promote research and innovation performance FDI has also been an important channel for economic across the business sector. Efforts to foster the integration with the EU. The evolution of FDI inflows adoption and diffusion of ICT are also underway in recent years has been volatile but on average the which could have an important impact on the ratio of FDI inflows to GDP remained above the prevalent services sectors. There is already evidence EU25 average over the period 2001-2006. FDI of good progress for example regarding ICT diffusion outflows remain very limited. In 2004, the ratio of as the rate of broadband penetration approaches the inward FDI stock to GDP reached 67.5% in 2004 EU25 average. which is among the highest in the EU25. The EU25 is by far the main investor in Malta and investment The promotion of a market-based adjustment is flows overwhelmingly target services sectors, in facilitated by improvements in the business particular financial services.33 environment, namely regarding the speeding up of the process for starting up a company and the increase of Despite the increasing market integration with the the quality of the regulatory framework. However, EU25, the price level of goods and services remained barriers to further restructuring remain as many around 25% below the EU25 average in 2005. The activities, namely in professional services, are still remaining price gap is mainly driven by services as heavily regulated. Competition pressure is also not yet the price level of goods was already around 91% of fully ensured in some sectors such as importation and the EU25 level. In contrast, price levels remain distribution of fuel products, retail, transport and particularly low in services sectors such as construction. Sectoral state aids also remain relatively recreational and cultural services and energy where high and their redirection towards horizontal prices are still administered (41% of the EU25 objectives in particular R&D is also lagging. average price level in 2005).34
31 This operator accounts for more than half of the industry’s total output and exports, see "Malta's growth predicament: from runner to laggard and back?", ECFIN Country Focus, vol. III, issue 14. 32 See: EU Industry Structure, DG ENTR, (forthcoming). 33 See: Balance of Payments - Direct Investment in Malta and Abroad, National Statistics Office, News release, 2 February 2007. 34 See: "Comparative Price Levels for Selected Consumer Services in Europe for 2005", Statistics in Focus, 35 See: 2006 European Innovation Scoreboard. no.12/2006, Eurostat. 36 See: Fourth Community Innovation Survey.
25 Convergence Report 2007 on Malta Technical annex
Table 5. Malta: Product market integration Malta EU25 2001 2002 2003 2004 2005 2006 2001 2002 2003 2004 2005 2006 Trade openness 1) (%) - - - 79.5 73.1 - - - 35.4 36.7 38.3 - Extra-EU trade in goods GDP ratio 2) (%) 22.9 22.8 22.2 20.4 17.4 21.3 9.9 9.4 9.1 9.6 10.4 11.1 Intra-EU trade in goods GDP ratio 3) (%) 33.6 32.9 33.5 35.7 33.6 32.8 19.0 18.5 18.4 19.0 19.6 21.0 Intra-EU trade in services GDP ratio 4) (%) ---16.215.6---4.64.74.9- Intra-EU trade balance in goods 5) -0.8 -0.9 -1.0 -1.1 -1.2 -1.1 89.4 96.2 90.7 77.9 72.6 81.4 Intra-EU trade balance in services 6) ---0.40.4---1.917.015.9- Intra-EU trade balance GDP ratio 7) (%) ----15.8-17.0---0.90.90.8- Total FDI inflows GDP ratio 8) (%) 7.3 -10.2 19.5 7.3 11.0 - 5.8 5.0 3.6 2.2 4.6 - Intra-EU FDI inflows GDP ratio 9) (%) - - - 5.3 1.1 - 4.3 3.7 2.3 1.6 3.7 - FDI intensity 10) - - - 2.3 0.2 - 3.9 3.7 2.5 1.9 3.8 - Internal Market Directives 11) - - - 6.0 1.2 1.0 - - - 3.6 1.6 1.2 Price levels 12) 75.5 73.7 71.2 71.8 72.5 - 100 100 100 100 100 100
1) (Imports + Exports of goods and services/2xGDP at current prices)*100. (Foreign trade statistics/ Balance of payments). 2) (Extra-EU Imports+Exports/2xGDP at current prices)*100. (Foreign trade statistics). 3) (Intra-EU Imports+Exports/2xGDP at current prices)*100. (Foreign trade statistics). 4) Intra-EU25 trade in services (average credit and debit in % of GDP at current prices). (Balance of payments). 5) Difference between export and imports of goods (credit minus debit) in bn euros. (Foreign trade statistics). 6) Difference between export and imports of services (credit minus debit) in bn euros. (Balance of payments). 7) Difference between export and imports of goods and services as a % of GDP. (Foreign trade statistics/ Balance of payments). 8) Total FDI inflows as a % of GDP (at current prices). 9) Intra-EU total FDI inflows as a % of GDP (at current prices). 10) Average value of Intra-EU25 inward and outward FDI flows, divided by GDP and multiplied by 100. 11) Percentage of Internal Market directives not yet communicated as having been transposed in relation to the total number. 12) Comparative price levels of final consumption by private households including direct taxes (EU25=100). Sources: Eurostat, Commission services.
Further economic integration with the EU, from the envisaged improvements in Malta's improvements in the business environment and infrastructure, namely regarding port and upgrading of the innovation performance of the interconnections to connection to Europe's energy economy will also promote the attraction of more networks. The ongoing process of integration is also FDI. FDI has been contributing to the diversification facilitated by the swift transposition of the EU of the economy's production structure, namely directives. According to the December 2006 Internal towards financial services and can also play an Market Scoreboard n° 15bis37, Malta further reduced important role as a means for technology, the deficit in the transposition of Internal Market organisational- and managerial-skill transfer. Trade directives in 2006, which is now at 1% compared to and investment relations with the EU will also benefit the EU25 average of 1.2%.
37 http://ec.europa.eu/internal_market/score/index_en.htm
26 Chapter 7 Additional factors
7.3. Development of the balance of semi-conductor firm dominating the market. The payments sector’s performance has reflected difficult global market conditions after 2001, thus underscoring the vulnerability associated with a narrow sectoral base in Malta’s current account balance has been in deficit a small economy. At the same time, Malta’s tourism since 1998 (except for 2002), averaging -5% of GDP, industry has performed sluggishly during the past with large merchandise trade deficits not fully years, reflecting both a fallout from geopolitical compensated by sizeable surpluses in the services concerns and intensified competitive pressure. balance. Year-on-year swings were large, partly Imports were underpinned by strong investment reflecting one-off factors that disproportionately activity, including by the public sector, while the oil affect the aggregate in an economy of Malta's size. bill increased strongly in line with global market After having recorded a surplus in 2002, the current developments. account balance worsened sharply to -8.2% of GDP in 2005. This was primarily due to a marked worsening In 2006, the current account balance improved to of the trade balance, whose deficit increased from 8 to 6.3% of GDP on account of a significant increase in 20% of GDP between 2002 and 2005, while the current transfers due to increased receipts from the services balance remained stable in that period. The booming online gaming industry. A slight adverse trend was compounded by a steady deterioration in trade balance was triggered by higher deterioration of the income balance. As a mitigating imports of capital goods (such as cranes, ships) which influence, net current transfers picked up strongly in masked a strong recovery in exports (especially 2005, following several years of marginal increases. pharmaceuticals, scientific instruments and electronics). The deterioration in surplus of services Over the last years, the Maltese current account trade reflected mainly a weak performance of the balance has been strongly affected by swings in the tourism industry. There is however a revival in this tourism and electronics sectors, as well as stronger sector following the arrival of low-cost airlines in exposure to import competition in previously well- November 2006. protected manufacturing sectors, partly related to EU accession. The electronics sector alone accounts for well over half of total goods exports, with one large
Table 6. Malta: Balance of payments (percentage of GDP) 2001 2002 2003 2004 2005 2006 Current account -3.8 2.4 -3.2 -6.4 -8.2 -6.3 Of which: Balance of trade in goods -14.3 -8.1 -13.1 -16.0 -19.6 -19.8 Balance of trade in services 8.9 9.4 9.8 9.8 8.0 6.2 Income balance 1.0 0.7 -0.5 -1.2 -2.8 -1.5 Balance of current transfers 0.6 0.5 0.6 1.0 6.2 8.8 Financial and capital accounts -2.9 -1.0 2.6 5.1 8.2 9.2 Of which: Net FDI 6.4 -10.0 8.5 7.4 10.5 27.4 Net portfolio inflows -12.6 -8.6 -32.3 -38.2 -46.1 -39.6 Net other inflows (1) 9.9 24.2 28.9 30.8 44.5 20.0 Net capital account 0.0 0.2 0.4 1.5 3.4 3.1 Change in reserves (+ is a decrease) -6.7 -6.7 -2.9 3.6 -4.1 -1.7 Errors and omissions 6.7 -1.5 0.6 1.3 0.0 -2.9
Gross capital formation 18.7 14.3 17.5 17.0 21.6 19.8 Gross saving 14.9 17.0 14.7 10.6 13.3 13.5
(1) Including financial derivatives Sources: Eurostat and Commission services.
27 Convergence Report 2007 on Malta Technical annex
So far, the financing of the current account deficits Extensive restructuring has taken place in the last few has been largely unproblematic, but the external years, with activity in shrinking sectors (such as position reflects substantial financing needs. While in clothing) being progressively replaced by sectors with 2004 net capital inflows did not fully match the competitive edge (pharmaceuticals, remote gaming, current account deficit, leading to a drop in external aircraft maintenance, financial services, auditing), and reserves, this was reversed again in 2005 in line with with product upgrading in the main exporting industry longer-term trends. Net FDI inflows constituted the (electronics). Increased openness to the world trade dominant category of external financing over the past after EU accession has contributed significantly to years, generally exceeding the current account this process. shortfall, though with some large year-to-year volatility. Reflecting sizeable capital transfers from A narrowing of the current account deficit to some 3- the EU and Italy, the capital account improved to a 4% of GDP is expected in the coming years. The main surplus of 3.4% of GDP in 2005 and 3.1% in 2006. factors behind this improvement should be exports of As a result, the deficit in the combined current and manufacturing goods (pharmaceuticals), higher capital account decreased from slightly below 5% of revenues from travel industry and tourism and higher GDP in 2004-2005 to 3.2% of GDP in 2006. current transfers (as a result of the buoyant remote gaming industry). Some caution is warranted in interpreting Malta's balance of payments data, as in recent years the A sustained improvement in Malta's external balance residual “net errors and omissions” were consistently will need to be supported by strengthened efforts to strongly positive, implying an overestimation of the maintain external competitiveness, including through current account deficit and/or an underestimation of policies fostering productivity growth, appropriate net inflows on the capital and financial account in the wage developments, and further progress in order of 2-3% of GDP. diversifying the sectoral export structure. A prudent fiscal stance is important to underpin domestic The outlook for Malta's balance of payments is savings. On the financial account side, ensuring a influenced by external factors (such as developments positive investment climate is vital to underpin FDI on global energy and electronics markets), but also inflows. crucially depends on prospects to improve the competitive position of the Maltese economy.
28